IFRS 3 and IAS 17 - Coursework Example

IFRS 3 and IAS 17 IFRS 3: Business Combinations IFRS 3 (after revision in January 2008) has become a standard that deals comprehensively with accounting and reporting matters relating to business combinations. It is simple and clear in its methodology of reporting acquisitions. The regulations prescribed under IFRS 3 are concise and interlinked to arrive at logical conclusions. Above all the ingredients of fair value, adoption of only purchase method for accounting acquisitions, and consideration of n-n- controlling interest in goodwill valuations has made IFRS 3 a tool that fairly present acquisition transactions under business combinations. Major issues of business combination are analyzed hereunder in order to determine the style, character, and extent with which those have been dealt by IFRS3. Clear & precise procedure of acquisition The process of accounting and reporting of business combination is stated with absolute clarity under IFRS 3 particularly after its revision in January 2008. IFRS 3 categorically states that only purchase method shall be applied for accounting and reporting for acquisitions. The standard has in a simple fashion established four following stages for applying the purchase method to regulate the acquisitions: a) Identification of acquirer b) Establishment the date of acquisition. c) Measurement, and recognition of identified net assets and the non- controlling interests (i.e. minority interest), if any. d) Goodwill or gain (negative goodwill) recognition and measurement This standard in not applicable to joint ventures, acquisition of asset or group of assets, and combinations of entities under common control that are not transitory, involvement of two or more mutual entities, and formation of a reporting entity for combining entities or businesses without ownership interests. In other words only those combinations are attracted under this standard that involves transfer of controlling interests with the acquirer. Acquirer gets these controlling powers in number of ways as under purchase of all assets, liabilities and rights of acquiree; or purchase of some of assets, liabilities and rights of acquiree that transfer controlling powers of acquired business; or establishment of a new entity taking over all assets, liabilities, and rights of combining entities That is why IFRS 3 makes it compulsory to identify an acquirer. Acquirer as per IAS 27 is the one who has control over financial and operating policies of the acquired entity, and these powers can be obtained in following ways, among others: Acquiring more than 50% of voting rights; Transfer of controlling rights under a statute or a contract; Powers to appoint or remove governing management; Holding majority voting powers in governing management to influence decision making. Concise method of compute cost of acquisition, goodwill, and non- controlling interests Revised version of IFRS 3 has eliminated whatever ambiguity was there in original version. IFRS 3 describes the fair value of an asset or a liability as the amount that is exchangeable at arm’s length transaction between parties having complete knowledge of that asset or liability. Hence cost of acquisition is fair value of net assets assumed (that is fair value of identified assets including intangible assets reduced by identified liabilities including contingent liabilities) and equity instruments issued by the acquirer in exchange of control of acquiree plus the cost directly attributable to acquisition. The important thing to note is that cost of acquisition or purchase consideration includes all interest of the acquirer into the acquired business. Also only those contingent liabilities are considered that have a measurable fair vale at acquisition date. Goodwill measurement has been regulated in a very concise way. Goodwill in a business combination is the difference between costs of acquisition (i.e. purchase consideration paid) calculated as above and the fair value of identified net assets acquired. The standard revised in January 2008 has provided two options for measuring non-controlling assets (that is minority interests) while calculating goodwill for business combinations as under: “ Goodwill is difference between considerations paid and the purchaser’s share of identifiable net assets acquired. This is a ‘partial goodwill’ method because the non- controlling interest (NCI) is recognized at its share of identifiable net assets and does not include any goodwill. Goodwill can also be measured on a ‘full goodwill’ basis, which means that goodwill is recognized for the non- controlling interest in a subsidiary as well as the controlling interest.” (Graham Holt, 2008)1 Fair Presentation of acquisition process Few ingredients of IFRS 3 like use of purchase method for reporting the acquisition, fair values basis of computations of cost of acquisitions, and consideration of non- controlling interest (NCI) in goodwill valuations make a fair presentation of accounting and reporting of acquisition under business combinations because of the following reasons: Under pooling of interest method of merger accounting, the balance sheets of two entities under business combinations are merged and no goodwill or gain is computed, which seems a fiction and out of this world. Business combinations are practical business transactions that are entered into for cashing the name earned by a business (i.e. goodwill) or for saving the loss prospectus. These realities of business combinations are truly represented under purchase method (also called acquisition method) of accounting for acquisitions. Consideration of fair market value rather than book value of assets and liabilities at the date of acquisition in order to compute cost of acquisition is a measure to acknowledge the realties; and that makes acquisition reporting under IFRS 3 an absolute transparent representation of real value of the entity being acquired. Corporate governance demands proper representations for non- controlling interests in business decision making. Keeping this objective in view the revised IFRS 3 has suggested both ‘partial goodwill’ and ‘full goodwill’ methods as options to consider non- controlling interests (i.e. minority interest) in goodwill calculations. This enhances the presentation value for reporting acquisitions following the regulations of IFRS 3. These three features are real contributories to add the fair presentation qualities while reporting for acquisitions under IFRS 3. Accordingly the regulations of IFRSs are not only clear in their application on acquisition transactions, but also they have a concise methodology making the application very straight forward. Moreover the attributes of only application of purchase method for acquisitions accounting, adoption of fair values of assets and liabilities in computation of cost of acquisition, and consideration of non- controlling interests adopting optional approaches in goodwill measurement has made IFRS 3 a unique document that produces fair presentation of acquisitions under business combinations. Word Count: 1063 Finance and Operating Leases as set out in IAS 17 IAS 17 has made specific regulations of accounting and reporting for finance as well as operating leases. Under finance leases the lessor transfers substantially all the rights and risks of ownership to the lessee, and all other leases are called operating leases. In this essay an effort is made to evaluate the validity of the distinction created by IAS 17 in defining the financing and operational leases while complying with the conceptual framework created for preparation and presentation of financial statements. In terms of IAS 17 finance lease (also called capital lease) arises where lessor transfers substantially all of the rights and risks of ownership to the leasee. Other than that all leases are to be treated as operating leases. At the same time the standard also qualifies its definition of distinction between the finance and operating leases by stating that classification largely depends upon the substance of the transaction rather than its form; and this qualification is the important factor in making distinction between finance and operating leases. It is often difficult to determine if a lease actually transfers the risks and rewards of ownership from lessor to lessee. In order to determine whether a lease is finance lease or not it has to be evaluated using following yardsticks. If either of the first two criteria as contained in IAS 17.10 applies, the lessee will ultimately own the property: Title to property transfers to the lessee by the end of lease term. The lease contains a bargain purchase option. Bargain purchase option is an option that allows the lessee to acquire the property on or before termination of the lease at a price that is significantly lower than anticipated market value of the property as of the date on which option can be exercised. In order to be considered a bargain purchase option, the option price must be low enough to leave very little doubt that the lessee will exercise it. If neither of first two criteria applies to the lease, it is analyzed in terms of rest of following three options stated in IAS 17.10. If any one of these criteria applies, the lessee will not own the property but it is assumed that substantially all of the rights and risks of ownership are being transferred: The non- cancelable lease term is equal to major part of economic life of leased property. In practical business 75 % or more is considered major part of economic life. The present value of the minimum lease payments is equal to substantially all of the fair market value of the property.(in practical business 90% of fair value is considered substantial portion) Leased asset is of specialized type that only lessee can use without major modifications. It must be noted that as per IAS 17 in calculating the present value of minimum lease payments, the lessor will always use the rate that is implicit in the lease. The lessee, on the other hand, will generally use the lessee’s incremental borrowing rate in calculating the present value. The lessee may use the rate implicit in the lease provided that it is lower than lessee’s borrowing rate and the rate implicit in the lease is known to the lessee. However when none of above five applies to the transaction the following checks as suggested by IAS 17 needed to be made in order to determine whether the lease is finance lease: Where the terms allows lessee to cancel the lease, the losses of the lessor associated with cancellation should be borne by the lessee. Gains or losses on fluctuation of fair value of residual value at the end of lease period shall be the responsibility of the lessee. Lessee is capable of carrying the lease for next term at lease money lower than the first term. IAS 17 has provided sufficient tests to determine whether lease is finance lease. Leases may be operating leases in which the lessor is receiving rent payments that will be recognized as revenue over the term of lease and the lessee is making the payments to be recognized as expense. So far as accounting and reporting on finance lease is concerned IAS 17 has prescribed that the lessee at the inception of a finance lease will record an asset and a lease obligation at the lower of fair value or present value minimum lease payments. The term ‘asset’ is one of the accounting elements that confirm to attributes of relevance, reliability, consistency, and comparability. “IASB paragraph 49 defines an asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. It defines a liability as a present obligation of the enterprise arising from past events, the settlement of which is expected to result into an outflow from the enterprise of resources embodying economic benefits.” (IMF, page 221)1 That means recording of lease as assets by lessee under finance lease confirms to the criteria of transaction being an ‘asset’ and a ‘liability’ as per conceptual framework with in which standards are being formulated by ISAB. Conceptual framework of IASB directs that information contained in financial statements must be ‘presented fairly’, and as per IAS 1.13 “Fair presentation requires the faithful representations of the effects of transactions, other events, and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income, and expenses set out in the framework. The application of IFRS, with additional disclosure when necessary, is presumed to result in financial statements that achieve fair presentations” (Deloitte IAS Plus)2. That means if regulations of any IAS/ IFRS are followed the result would be fair presentation of financial statements as envisaged in the conceptual framework of IASB. When in case of finance lease, the lessee recognizes asset at the inception of lease and an obligation to pay following the regulations of IAS 17, the lessee is conforming to the elements of ‘assets’ and ‘liabilities’ as explained in paragraph 49 of conceptual framework issued by IASB as stated above, and also it will be treated as fair representations of a finance lease transaction That means the framework created in IAS as stated earlier in this write up for determining the distinction between financial and operation lease are valid steps to constitute the separation between finance lease and operation lease. Thus the distinction created by IAS 17 between finance and operating leases is valid as it confirms to accounting parameters stated in the conceptual framework of IASB as per IAS 1: Presentation of Financial Statements. Word Count: 1109 References Read More